From June 2023, the The IRS will allow sponsors of individually designed 403(b) plans to request a letter of determination for a new plan or to terminate a plan using the same program currently used by 401(k) plans and other qualified plans under the section 401(a).
Tax Proceeding Announcement 2022-40 expands one of the IRS and Treasury’s programs for approving retirement plans, allowing 403(b) plans — which are used by some public schools, churches, and charities – to claim the same favorable tax treatment as qualified pension schemes.
The implementation of the new rule will be phased by employer identification number. Sponsors with an EIN ending in 1, 2, or 3 can begin applying for Determination Letters beginning June 1, 2023. Those ending in 4, 5, 6, or 7 must wait until June 1, 2024; and those ending in 8, 9, or 0 must wait until June 1, 2025. Termination of 403(b) plans may require a plan termination letter regardless of EIN as of June 1, 2023.
Determination letters are often used by qualified pension plans to seek official IRS approval, according to Robert Abramowitz, benefits attorney and partner at Morgan Lewis. Although these letters are not required by law, it is common practice for large 401(a) qualified retirement plan sponsors.
These letters are essentially an insurance policy against IRS audits or legal flaws in the design of the plan, as the sponsor can rely on previous IRS approval. It also allows a sponsor to catch a problem early by referring it to the IRS before investing heavily in a flawed plan. Additionally, sometimes a third party, such as a creditor, will ask a sponsor to obtain or share their Letter of Determination as a condition of service, Abramowitz says.
Under Tax Procedure 2022-40, the Letter of Determination process will now be available for 403(b) plans. Abramowitz describes it as “a big change” for 403(b) plans and a change to their advantage. It will streamline the plan adoption process and make it more similar to the process for qualified retirement plans, such as 401(k) plans.
David Ashner, employee benefits attorney at Groom Law Group, said individually crafted 403(b) plans couldn’t get formal IRS approval before this change.
Abramowitz warns, however, that while this is “good news for many,” longtime 403(b) plan sponsors who request letters of determination may have longstanding flaws exposed in the process. He explains that sponsors of old plans should “be careful what you ask for. The IRS is watching things carefully.
He notes that proponents normally seek determination as part of the initial adoption of the plan to avoid having to fix problems later.
Ashner adds that many 403(b) sponsors are institutions such as universities that often have very unique plans that date back decades. This change is something that 403(b) sponsors have wanted for a long time, and there should “be a lot of interest” in acquiring Letters of Determination.
Ashner explains that the change also allows 403(b) sponsors to request letters of determination when terminating a 403(b) plan. This allows them to get approval from the IRS to properly close a plan. Although rare, Ashner says that if a plan is terminated and the IRS later determines the plan was ineligible, the sponsor as well as the participants could face onerous tax consequences as the plan would no longer be considered. as tax-efficient.
The full text of tax procedure 2022-40 is available here.